Did Germany reject or just postpone capacity payments?

The big news from Germany in the energy sector in January is the government’s apparent rejection of a capacity market. But energy giant E.ON says the issue will not go away. Craig Morris explains why Germany is likely to get a small capacity market through the backdoor.

One block of the coal power plant in Mannheim is part of the strategic reserve for this winter.

For my readers who don’t know what capacity payments are, let’s start with a quick introduction. Think of electricity as a mobile internet connection. You might have a flat rate, and you may have chosen a cheap one with a lower maximum data speed – fast data speeds cost more. Your provider charges you based on capacity, meaning the potential speed offered regardless of how much you consume. These are capacity payments. The electricity sector is a bit different. It is generally based on the amount of electricity you consume (kilowatt-hours), not the size of your power line (kilowatts). The problem is that solar and wind production fluctuates greatly, but we still need the same amount of power plant capacity to switch on at times of low wind and power production. The current energy-only market in Germany makes it increasingly uneconomical for some of these back-up power plants to stay online, and utilities are asking the government to pay them for their standby capacity service.

In this chart, we see that wind power (green area) kicked in strongly in the third week of December but was extremely low in the first week of the month. Domestic demand for conventional power (the large gray area) fell as low as 20 GW before Christmas, a level that is painfully close to the must-run (minimum) production level of Germany’s conventional fleet. Exports (the area below the baseline) reached as high as 7 GW at those times, thereby rescuing these plants. Yet, demand at the beginning of the month regularly reached around 60 GW, three times higher.

In the third week of the month, power plant operators could only sell a third as much power, and prices were also much lower at the time. The result is unprofitability. But shutting down a lot of plants is not an option because we still have to cover the absolute peak for the year, which is close to 80 GW (including exports).

Why not just pay power plants to stay online even when they are not selling power? That is the idea behind capacity payments, but the concern is that these payments will prop up the very plants that need to be shut down, particularly coal plants. Various proposals were made to make capacity payments contingent upon, say, carbon emissions. In addition, experts have pointed out that strengthening demand-side management has the same effect, so a capacity market should not be limited to power generators.

In January, Industry and Energy Minister Sigmar Gabriel openly stated his opposition to the capacity market concept, which is a bit of a reversal. The coalition agreement signed between the Social Democrats and the Christian Democrats in 2013 speaks of an “emergency reserve” along with capacity payments in the long term. Now, Gabriel believes that the current market can take care of the challenges mentioned above by itself.

German power companies cannot, however, simply shut down their generators that become unprofitable. Instead, they must apply for permission from the Federal Network Agency, which reviews the grid situation to determine whether that power plant is needed to prevent blackouts. I explained the procedure last year here. Since then, the list of power plants seems to have grown slightly to cover 8,051 megawatts, only 508 of which has actually been shut down; the rest remains on a waiting list.

This is where the position of the big utilities comes in. Bloomberg has a good review of the debate, which took place in German. E.ON and RWE essentially argue that current market trends discourage investments in new capacity, which is true. It is also true that Germany aims to reduce its reliance on conventional energy, so new conventional power plants would generally be counterproductive. The question is what happens with the plants that utilities want to shut down but are needed to maintain security of supply.

The German government has apparently sided with renewable energy association BEE, as Chancellor Merkel stated at the organization’s annual gathering in January. Germany currently has a “strategic reserve” of 2.6 GW. These power plants almost never run, but they are kept on standby just in case. In the past few years, they were only used for a day or two annually, and in 2013 they were unable to respond in time when four conventional power plants simultaneously failed in southern Germany – meaning they were actually not used at all that year.

The BEE’s proposal would have this strategic reserve become more flexible (able to react faster) and larger at around 7 to 10 gigawatts (report in German). The amount is roughly equal to the plants that the utilities want to close, but that overlapping is coincidental. The BEE wants to focus more on flexible gas turbines than on the large number of coal plants in that list.

For the time being, E.ON and RWE will probably have to make do with this smaller capacity market, which will probably still be called a strategic reserve. Currently, RWE would like to close ten power plants; E.ON nine; EnBW (Germany’s fourth largest utility) seven (the list is available as a PDF in German).

The German government has already rejected the idea of setting up a capacity market with France (report in German). The decision has drawn some criticism, with Germany being told it is not working in step with its neighbors. And indeed, other European countries are forging ahead with the idea of capacity markets – a topic we will have to come back to in future posts.